All IMHO. It is my analysis. Please check with your own expert. I would appreciate any feedback/correction and look forward to the analysts commentary.
I think todays announcement about accounting changes for goodwill is about time. I don't know if the changes are because of the change in management with Dr Bateman retiring
To attract doctors, Primary offer to purchase their practice, the value of which is basically 'goodwill' - the patient base who they anticipate will attend their medical centre. They are not buying the doctor, they are buying her/his patients. Presumably, the patients are less likely to attend the new Primary Medical Centre if the doctor is not working there, at least initially. The doctor's like this goodwill payment as it is tax effective. To entice the doctor to move to their medical centre, they are separately contracted to work in Primary's facilities. According to the ASX release, the typical contract is for 5 yrs and their example goodwill is $400,000. The info on these contract arrangements is in the public domain in a number of NSW Supreme Court judgements where Primary and the Doctor have been in dispute and even the judiciary (2002 NSWSC1214) seem to have commented on the nature of the goodwill.
Up until now, once PRY have purchased a doctor's practice they apparently have placed the cost onto their books, exclusively as goodwill, and left it there to accumulate as an asset, not an expense. In June 2014, the Medical Centre Goodwill was about 1.3 Billion Dollars and had been increasing progressively over the years. The notes to the accounts state that this is tested for impairment each year and will be immediately adjusted if appropriate. I stand corrected, however I cannot see any episode of impairment (until now, and it is certainly immediate!). Primary and their Auditors clearly determined this an accurate assessment. I would imagine that in their impairment assessment they considered those doctors who did not renew their contracts and needed replacing by purchasing another practice. PRY may also have to pay further incentives to other doctors to renew their contracts - I don't know, as this has not been disclosed to my knowledge. I was looking at purchasing PRY shares a few ago, however I was concerned about the treatment of the goodwill as it seemed to exceeded the net assets by a fair bit. What would happen if none of the doctor renewed their contracts? Over a 5 yr period the goodwill would have disappeared (as would presumably the patients left without doctors - a situation that would also impair the pathology and imaging assets, whose goodwill would otherwise appear pretty stable and have not been revised in the latest half year results). This is an extreme example for illustrative purposes, however it does demonstrate how important it is for Primary to keep their doctors content on more than just the financial front.
If the doctor's existing patient base is near the Primary Centre, it is reasonable that most patients will follow. The further the geographic isolation, the less likely patients will stay with the doctor. In the PRY announcement they have reconsidered how they handle practice purchases. Primary seem to have made a 10km cutoff. Within this distance they believe patients are likely to remain 'sticky'. I think that is a reasonable assumption, although it might be a bit generous, particularly in metropolitan areas where there are lots of practice to select from, and many that do offer appointments. How many patients move may also be influenced by how much practice style in a primary centre varies from what they have been used to.
For practices within the 'sticky' zone, instead of keeping the practice purchase goodwill at 100% as presently, they are reducing it to 70% goodwill that stays on the books at this value, and 30% as intangibles that are depreciatred to zero over 5yr. Intangibles allow for the fact that a percentage of doctors don't recontract. There is no mention of how they will treat any incentive payments made to doctors to renew their contracts. It's a bit hard to see how they can justify further goodwill if the doctor and the patient are already at the Centre. I guess they will just expense this over the contract.
Presumably, should a centre be unable to attract any doctors in the future, it would also see that 70% goodwill radically impaired. They do have some good locations and this goodwill is probably fairly reliable, however there is still a risk. Contract restraints do preclude their doctors just setting up over the road, however they do not prevent others doing this. It also does not prevent a group of doctors from one Primary Centre swapping with another group and each setting up near the opposing primary centre. It might be helpful if PRY surveyed their doctors and published their future intentions. I imagine they may be reluctant to do this, however for a business with such a large goodwill component it might be pertinent to investors.
For practices outside the 'sticky' zone they have determined that the probability of the patient base moving is slight, and no longer attribute any goodwill to this. The entire purchase price is converted to intangible and depreciated over the 5 yr (or whatever) contract term.
I would have thought the approach they have now adopted should have applied all along.
Primary disclose that approximately 80% of practice costs will typically be amortised over 5yrs, so I guess a significant number of practices are outside the 10km radius.
That said they have just adjusted the last half year results for the FY 13/14 by reducing medical centre goodwill by 426 million from 1.3 billion to around 880 million dollars. Approx 140 million is transferred to intangibles that will depreciate over 5 yrs. This dropped Dec 2013 profit from 107 million to a loss of 26 million. Forward years will also be reduced by about 28 million dollars a year as the intangibles depreciate. They still hold 880 million of Medical Centre Goodwill. I cannot see any explanation as to what this actually is, how it is treated, and if there are any plans to impair this. I'm no expert, however if on average 80% of goodwill will be amortised as intangibles (if I have that right) why didn't they transfer 80% of all the Medical Centre Goodwill to intangibles?? Is it goodwill on something else?
Another problem that I forsee is that the present adjustments only apply to presently contracted doctors or those gone by (maybe). As they expand, and or to replace doctors who do not want to recontract (they used to publish attrition rate - this no longer seems the case) they will need to recontract new doctors. If they have say a 1000 doctor on their books and they need to buy a 1o00 practices over the next five years to account for attrition ( it won't be this bad as an indeterminable number of doctors will recontract, although I suspect this is likely to entail an upfront incentive - especially if the Doctor's assume they are in the box seat). In the example case of $400k per doctor, this equates to 80% of $80k per doctor per year off the bottom line. If I have it right, for the next five years PRY will be depreciating the new current intangibles over 5 yrs - say ? 28 million plus per year, and another say ? 64 million dollars a year for newly contracted doctors. This is extreme and based on all their doctors needing replacement or equivalent. That looks way too much - there must be a problem with my calculations! Please help.
I don't know what an average doctor grosses. Lets assume they only bill for a Standard Consultation (there will be extras) - say, gross billings $40 from Medicare if they are all card holders or kids (this is unrealistic). Assume the doctor sees 200 patients per week. That is $8000 per week. Assume they pay Primary half of this in a service fee. That is $4000 per week to primary before costs. In their large centres they keep about 56% of this = $ 2240 per week net. Say the doctor works 48 weeks a year. Primary bill the doctor approx $107,000 per year. After deducting the annual intangible component they are left with net of $41,000 per doctor. That is $ 41 million net per year for a 1000 doctors. The figures are a bit rubbery but they seem approximate enough. Presumably, the cost of capital for the purchase is already accounted for in the overheads. The doctors also indirectly contribute to pathology and imaging and help maintain these profit centres
Any way, that's my 2 bits worth.
PRY Price at posting:
$4.63 Sentiment: None Disclosure: Not Held
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